Understandably, this raises some questions. Today let’s look at the four most common:

1. What makes Vanguard so special?

When Jack Bogle founded Vanguard in 1975 he did so with a structure that remains unique in the investment world: Vanguard is client-owned and it is operated at-cost.

Sounds good, but what does it actually mean?

As an investor in Vanguard Funds, your interest and that of Vanguard are precisely the same. The reason is simple. The Vanguard Funds, and by extension the investors in those funds, are the owners of Vanguard.

By way of contrast, every other investment company has two masters to serve: The company owners and the investors in their funds. The needs of each are not always, or even commonly, aligned.

To understand the difference, let’s look at how other investment companies (most companies in fact) are structured. Basically, there are two options:

1. They can be owned privately, as in a family business. Fidelity Investments is an example.

2. They can be publicly traded and owned by shareholders. T. Rowe Price is an example.

In both cases the owners understandably expect a return on their investment. This return comes from the profits each company generates in operating its individual mutual funds. The profits are what’s left over after the costs of operating the funds are accounted for — things like salaries, rent, supplies and the like.

Serving the shareholders in their funds is simply a means to generate this revenue to pay the bills and create the profit that pays the owners. This revenue comes from the operating fees charged to shareholders in each of their individual funds.

When you own a mutual fund thru Fidelity or Price or any investment company other than Vanguard, you are paying for both the operational costs of your fund and for a profit that goes to the owners of your fund company.

If I am an owner of Fidelity or Price I want the fees, and resulting profits, to be as large as possible. If I am a shareholder in one of their funds, I want those fees to be as modest as possible. Guess what? The fees are set as high as possible.

Now to be clear, there is nothing inherently wrong with this model. In fact it is the way most companies operate.

When you buy an iPhone built into the price are all the costs of designing, manufacturing, shipping and retailing that phone to you. Along with a profit for the shareholders of Apple. Apple sets the iPhone price as high as possible, consistent with costs, profit expectations and the goal of selling as many as they can make. So, too, with an investment company.

In this example I chose Fidelity and Price not to pick on them. Both are excellent operations with some fine mutual funds on offer. But because they must generate profit for their owners, both are at a distinct cost disadvantage to Vanguard. As are all other investment companies.

Bogle’s brilliance, for us investors, was to shift ownership of his new company to the mutual funds it operates. Since we investors own those funds, thru our ownership of shares in them, we in effect own Vanguard.

Any profits generated by the fees we pay would find their way back into our pockets. Since this would be a somewhat silly and roundabout process and, more importantly, since it would potentially be a taxable event, Vanguard was structured to operate “at cost.” That is, with the goal charging only the minimum fees needed to cover the costs of operating the funds.

What does this translate into in the real world?

Such fees are reported as “expense ratios.” The average expense ratio at Vanguard is .20%. The industry average is 1.12%. Now this might not sound like much, but over time the difference is immense and it is one of the key reasons Vanguard enjoys a performance as well as a cost advantage.

With Vanguard, I own my mutual funds and thru them Vanguard itself. My interests and those of Vanguard are precisely the same. This is a rare and beautiful thing, unique in the world of investing.

2. Why are you comfortable having all your assets with one company? Isn’t this what tanked investors with Bernie Madoff?

Because my assets are not invested in Vanguard. They are invested in the Vanguard Mutual Funds and, thru those, invested in the individual stocks, bonds and REITS those funds hold. Even if Vanguard were to implode (a vanishingly small possibility), the underling investments would remain unaffected. They are separate from the Vanguard company. As with all investments, these carry risk, but none of that risk is directly tied to Vanguard.

Now this can start to get very complex and for the very few of you who care, there’s lots of further info you can easily Google. For our purposes here, what’s important to know is:

1. You are not investing in Vanguard, you are investing in one or more of the mutual funds it manages.

2. The Vanguard mutual funds are held as separate entities. Their assets are separate from Vanguard, they each carry their own fraud insurance bonds, each has its own board of directors charged with keeping an eye on things. In a very real sense, each is a separate company operated independently but under the umbrella of Vanguard.

3. No one at Vanguard has access to your money and therefore no one at Vanguard can make off with it.

4. Vanguard is regulated by the SEC.

All of this, by the way, is also true of other mutual fund investment companies, like Fidelity and Price. Those offered in your 401k are, in all likelihood, just fine too. (If you have an employer sponsored retirement plan, like a 401k, that doesn’t offer Vanguard funds by all means invest in it anyway. Especially if any company match contributions are offered. Those are free money and an instant return on your investment.)

It is NOT true however for what are called Private Investment Funds. Those are where you turn your money over directly to an individual or group of individuals to manage and invest. That’s what Madoff was running.

3. What if Vanguard gets nuked?

Ok, let’s be clear. If the world ends on December 21, 2012 as evidently the Mayan Calendar suggests it might, everything you have invested in Vanguard (or elsewhere) will go up in smoke. But that’s not gonna happen. (Come December 22nd, I’m putting “told you so” right here.) (Told you so.)

If a giant meteor slams into Earth setting the world on fire followed by a nuclear winter, your investments are toast.

If super volcanos or global warming or viruses or an ice age or the reversal of the magnetic poles or AI robots or nanobots or maybe Zombies take us out, investing with Vanguard will be of no help at all.

But lesser disasters can and do happen. Vanguard is based in Malvern, Pennsylvania. What if, God forbid, Malvern is nuked in a terrorist attack? What about a cyber attack? Hurricane? Pandemic? Power outage?

Every major company and institution is aware of these dangers and each has created a Disaster Recovery Plan. Vanguard has one of the most comprehensive going. The company is spread across multiple locations. Its data is held in multiple and redundant systems. You can check out their plan here: Business Recovery Plan

But, if you are expecting a planet or even just a civilization ending event, Vanguard’s not for you. But then, no investments really are. You’re already stocking your underground shelter with canned goods. Short of that, you can sleep just fine with your assets at Vanguard. I do.

4. Am I on the take?

This blog is such strong a proponent of Vanguard it is reasonable to ask….

“Am I on the take?”

Nope. Vanguard doesn’t know I’m writing this and they are not an advertiser. Nor do they pay me in any fashion whatsoever.

(However, this blog does participate in Google Adsense. It is possible that when they choose the ads that appear, Vanguard’s might be one of them.)

For my International readers — an Addendum: With its client centered focus, Vanguard is growing rapidly and now is available in many countries outside the USA. You can check the list out here: Vanguard Global

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A great teacher I was blessed to have told the class repeatedly, “If you have a question, odds are another student has the same question, so please don’t hesitate to ask it.”

Thank you Eric for asking it, and for helping encourage jl to write it. Thank you jl for the direct answers to these questions, and for the many posts of your I’ve read (slowly working my way through them).

Beautifly written as always, and very informative. I love Vanguard, but I am also one of those who does not invest ALL my money with them. I understand the risks (and much better now, thank you), but I while I am sure that majority of the money invested with them would be returned eventually, if they were to implode, I still worry about how much time and effort would that take.

And yes, to illustrate how “management fees” impact the mutual funds and investments in general, I did a spreadsheet last year (because financial firms do not give you that information easily), and I found out the in the 10 years my company and I were contributing into Great West Life (Canadian Company) employer sponsored retirement fund, fund managers made more money on my money than me. They made about 2% return over 10 years, I made only 1.6% average return. I would love to dump them, but when company copays $1 for each $1 that I contribute (up to a certain level), and I get to defer taxes until retirement (RRSP), I am getting at least 100% return on my money instantly 🙂

Thank you sir! Always nice to see you here. You make a couple of very important points.

I should have pointed out (and in fact will edit the post to add) that the odds of Vanguard imploding are vanishingly small. Certainly small enough not to be a factor in my choice of investments. Further, since only long-term money should be invested waiting a few months if the unthinkable should happen is not a problem. I keep cash on hand for immediate needs.

Great illustration of the impact of fees on returns, but even more important is your excellent point about employer sponsored retirement funds; what we call 401k here in the USA.

Unfortunately, few of these plans offer Vanguard funds as an option. When I was working mine didn’t. But, as much as I love Vanguard, if your company offers such a program with a contribution match, GO FOR IT!

This is the reason in #2 in my post I have the line: “All of this, by the way, is also true of other mutual fund investment companies, like Fidelity and Price. Those offered in your 401k are, in all likelihood, just fine too.”

I should have been clearer. Mmmm. Think I’ll edit and add this point too.

Personal finance is not a priority in formal education. Hah, even WSJ and Bloomberg have a crappy personal finance section. The best advice comes from reading lots of pf bloggers.
I took lots of classes in finance, and only a couple professors mentioned stocks, but never really talked about how to get started, the advantages, etc.

Nice to see you back off your holidays JLC, I like your clear explanation of all things financial and quit often link them on my facebook page but unfortunately most people don’t have my interest in finance and shares.
But getting to your article and Vanguard (of which I am a fan) and the company structure seems to be very similar to a mutual society or Cooperative here in the UK.
Now I had the pleasure of working for an old Cooperative http://www.co-operative.coop/corporate/aboutus/ourhistory/
and actually its a very different atmosphere to any other company that I have worked for and it’s true that ethics and honesty was more important there than any other company.

But I must worn that in a old mutual or cooperative where the original company creator has gone, sometimes they can get over bloated and inefficient (Vanguard is in it’s infancy compared to The Coop) and the guys at the top can sometimes become overpaid, old and less interested in the company and more interested in retiring.
Now the Coop is making a comeback and is more efficient and has got some of it’s spark back but this has taken more than 10 years to do.
When they made me redundant they informed us and said the depot was to be closed quickly and it took 3 years (and that is fast for the Coop).
I am not saying this will ever happen to Vanguard but you have to keep your eyes open.

Thanks Steve, and thanks for linking some of this stuff on your facebook page. I always appreciate readers passing the blog along to their pals.

wow. that’s some history in the link you provided.

your concern about mission and value drift in organizations once a founder leaves is well worth consideration.

When Jack Bogle stepped down as Vanguard’s CEO in 1996 it gave me pause and focused my attention. Since then there have been two more CEOs and the course and values remain rock solid. To a great extent the organizational structure locks them in and the core beliefs are deeply engrained. I’m not much worried.

That said, were I to notice any drift I’d shift into high alert. For now and the foreseeable future, while I’ll always keep an eye open, I sleep well at night.

While I do have Vanguard in some of my 401k holdings. When I tried to roll over a Roth IRA into a Vanguard fund, I found that some of the funds are closed to new investors. In fact, some of your favorites you mention in earlier posts.
Jack Bogle is certainly a pioneer in the investing world, I found the Bogleheads guide to investing to be a good read for the Jr. investor like myself. Wish I would have done this much early in life…
Vanguard certainly has lower fees, more of your money working for you vs fees taking a cut of your cash. How do you feel about Reits? Also would like to hear your take on dividend investing? Seems to be an easy way to reap cash quarterly based on what I have read so far…
From prior posts seems you are not a big fan.

Just did a quick check and all are still open to new investors. Which have you found closed?

I do use, and link to, the Admiral version of these funds which have a lower expense ratio but a 10k investment minimum. However each also has an “Investor Shares” version and Vanguard provides links to those at the top of the page.

One of the four funds I use is a REIT. Combined with the equity in my house it comprises 25% of my portfolio. Real Estate held this way in my inflation hedge.

My concern with dividend investing is:

1. It requires selecting individual stocks, a complex endeavor that almost always underperforms the Index.

2. It focuses on only one of the ways companies produce value and return to shareholders.

Thanks, I have not made the move to dividend investing. I am more of a set it and forget it kind of person. So the Index funds do meet my style. I will look again at the Admiral versions offered. Thanks again!

Good writeup on Vanguard, Jim. Index investing is the safest way for most, although I feel people should also know how to do some basic valuation and understand the principles behind income statements and balance sheets.

Investing knowledge is something that interests you and me. I certainly agree that anyone planing to actively invest by picking individual stocks had better be able to do some basic valuation and understand the principles behind income statements and balance sheets.

But even then, with vanishingly rare exception, they will underperform an index fund like VTSAX. Their effort and knowledge will actually end up costing them money.

The second thing I’ve come to understand is the vast majority of people have zero interest in investing and certainly none in income statements and balance sheets. Yet these folks also want/need to be financially secure.

The good news is that very successful investing can be had with very simple tools.

I am a young guy, 24, looking to start saving more towards financial independence. What is the best option to buy Vanguard funds if I want to have access to them before the minimum withdrawal age set on IRAs? I already have a Roth IRA and am currently at a company that does not offer a 401K plan. Any advice would be incredibly appreciated.

1. How likely are you to withdraw this money early and incur the penalties. If you are planning, say, to buy a house and this is your downpayment money you want to avoid IRAs. If you are just thinking, OMG what if I get in trouble and need this cash, that’s something else.

2. Are you in a high enough tax bracket to make the deduction worthwhile? Most 24-year-olds are not. Remember, IRAs (except ROTH) don’t eliminate your tax payments they only delay them until you pull the money out. I, for example, am now in a higher tax bracket retired than I was in my 20s.

I opened a Vanguard account yesterday and qualified for concierge service for my retirement rollover to a Vanguard IRA. I must say that the fellow that I talked to would be a mirror of what you have said repeatedly in your blog. He could’ve steered me to any number of funds for a retirement portfolio and patiently answered my ‘what if’ questions pertaining to different mixes of funds. The choice that I ended up with was the Target 2020 fund, I may add a REIT fund as a small percentage if I feel that I can tolerate the added risk. I can’t say enough good things about my experience with Vanguard. I have some real peace of mind now thanks in large part to you and your blog. Thanks!

Just a question though, that may or may not be related to this. I live outside the US and I currently invest in Vanguard ETFs through Standard Chartered brokerage. They have a bit of commission and currency spread but those are expenses I cannot avoid and I am willing to shoulder. Vanguard individual investor services are not available where I am from and SC is one of the few that allow us to trade in the US stock market.

My question now is, if it’s Standard Chartered that gets nuked, will my investments disappear with it even if I bought Vanguard ETFs shares (Standard Chartered acts as the custodian)?

I’m not sure if you would know the answer to this but just like to hear your thoughts if ever.

Unfortunately, I am not at all familiar with Standard Chartered. But, if it is like most brokerages and mutual fund companies, your ETFs should be fine. They are separate things from SC and so you are not invested in SC, but rather just thru them as your broker.

But because there is much at stake here, I would continue your research beyond my opinion.

I am a small businessman who offers a 401K to his employees. Our current 401K administrator doesn’t offer much advice or value, and my staff is unhappy with him/them. Is there a way I can set up a 401K through Vanguard?

One point though I would like to raise. Because Vanguard appoints fund managers to allocate the investing parties capital accordingly (via computer analysis), what assurance do we have that such managers are allocating said funds as described within the stated fund structure?

Great Series!!! I am on board with the Vanguard philosophy but unfortunately have a large amount in funds at Merrill Lynch from my younger days blindly listening to family advice (parent has a friend who is my financial adviser at ML). I just realized one of the funds has a 3.68% expense ratio with a 1.0 load!!! I’m wondering if you have any advice on the best way to sell and transfer funds while minimizing taxes and penalties on a non-retirement/taxable account. I am in a high tax bracket and would prefer not to get hit on all angles by this mistake.

Over these past few years writing this blog, I’ve begun to learn that many are faced with this same situation: High fee funds bought years before that the robust market has given large capital gains now waiting to be taxed.

Obviously, in tax-advantaged accounts these can be moved instantly with no tax consequence. But it taxable accounts there is no easy answer.

A lot depends on how big a gain we are talking about.

Second, there are no government penalties in selling out of these funds, just the tax due. But some of the fund companies levy their own exit fees, a despicable practice.

Third, capital gains taxes are fairly modest.

For 2014:
Under the 25% tax bracket the tax is zero
For the 25%, 28%, 33% and 35% brackets it is 15%
Once in the top bracket of 39.6% it is 20%

With those points in mind, here are a few approaches to consider:

1. If you can see a year coming when you’ll drop below the 25% bracket, sell and move your funds then and you escape tax free. Or if you are in the top bracket and see a time coming when you’ll drop to 35% or less and can take the cap gain hit at 15% instead of 20%.

2. Sell and transfer the funds over a period of several years, starting with the ugliest, highest fee ones first.

3. If while pursuing the strategy in #2 the market takes one of its periodic major dives, use that opportunity to then move all your funds while prices are depressed and the cap gain hit will be less.

4. Rip the bandaid off all at once — sell/pay the tax and be done with it — lick your wounds and move on.

5. Of course if any of your taxable investment have losses in them, you can sell those to offset some of your gains.

Sorry I don’t have any magic bullets to offer here. But as problems go, this one isn’t the worst:

You do have capital gains and that’s always something to celebrate.
Once you sell and start anew at Vanguard your cost basis will be reset.
As taxes go, capital gains get favorable treatment.

Thank you for your super informative blog. My husband and I have really learned a lot. I have a mutual fund issue that I’m hoping you can help me out with. My 401k only offers Fidelity funds. I checked out the expense ratios and management fees of the 2 funds that I’m currently investing in and they were indeed higher than I liked. I transferred everything to the only index fund that they offered which mirrors the S&P 500, which is called “BlackRock Equity Index Fund M”. The thing that caught my eye was that they said, “This investment is not a mutual fund.” This got me worried. Are they one of those Private Investment Funds that you warned us about? This is what they say on their page:

“The Fund is a collective investment trust maintained and managed by BlackRock Institutional Trust Company, N.A. (“BTC”). The Fund shall be invested and reinvested in a portfolio of equity securities with the objective of approximating as closely as practicable the capitalization weighted total rate of return of that segment of the United States market for publicly traded equity securities represented by the larger capitalized companies. The criterion for selection of investments shall be the S&P 500 ® Index.
The Fund may invest through one or a series of collective investment trusts managed and trusteed by BTC.

When deemed appropriate by BTC and unless otherwise provided in the Fund’s investment strategies, BTC may invest all or any portion of the Fund in one or more futures contracts, forward contracts or other similar assets for the purpose of acting as a temporary substitute for investment in securities.

In the event of a conflict between this summary description of the Fund’s investment objective and principal investment strategies and the Trust Document under which the Fund was established, the Trust Document will govern. For more information related to the Fund, please see the Fund’s Trust Document, Profile and most recent audited financial statements.”

I’d appreciate your input. I just transferred my entire life’s 401k over to them and I want to know if I need to frantically undo it.

You have nothing to worry about with this fund (as far as structure goes). It is not a private investment fund of the Madoff or hedge fund kind. A collective investment trust leverages the economies of scale available to fund sponsors and qualified plans, such as 401k plans. This translates to lower expense ratios in many cases. The trust is an entity legally separate from BTC. It essentially operates similarly to a mutual fund, but it’s not publicly traded due to the nature of how it is established. Since the fund is within your 401(k), it is subject to the provisions of ERISA.

Vanguard offers such funds to its clients, my employer being one of them. We have the Trust version of their Target Retirement Funds in our plan lineup, as the trusts carry lower ERs than the mutual funds. Also, the stable value option in our plan is technically a collective trust.

I’m happy to provide more information if you need it, but hopefully this puts your fear to rest.

I stumbled upon your Stocks series yesterday (after clicking through several articles about how to achieve FI) and have found the information very useful.

I have a question about trading platforms. It’s clear to me that Vanguard is an exceptional choice, however I already have a roll-over IRA and brokerage account at Scottrade. On the site, it looks like I have access to VTSAX Admiral Shares, with a gross expense ratio of 0.05% and max management fee of 0.03%. So far so good… Would I be correct in assuming that I could enjoy the benefits of Vanguard even if I purchased the funds through Scottrade accounts, instead of moving them to Vanguard accounts? Or are there other financial or qualitative benefits to switching to Vanguard? TBH switching sounds like a pain, and I do like the no-frills and cheap trades at Scottrade, but I want to be sure this is the right choice.

Personally, I would make the switch to Vanguard and be done with it. For a little effort now you’ll be in the best place forever. Plus you’ll get rid of that “max management fee of 0.03%.” Why pay Scottrade an annual fee for the privilege of holding VTSAX?

Vanguard also offers cheap trades and if your balance is high enough they are even free.

I just finished the whole stock series. Jeej me. You really did a superb job, and I will definitely buy a couple copies of your book once it’s published. That will make some great gifts for my younger cousins. Heck, I wish somebody had given me such book when I was 15.

The reason for posting though is that I was wondering whether you have a certain routine to follow up on news related to Vanguard. I mean if I am going to invest all my capital with this one company, which I likely will, I want to know all the ins and outs of it.

Ow and btw, you really look like one of my former supervisors. That guy really taught me a lot about life. And so did your blog. Maybe it’s a special gene?

If all goes well, today I should have the major rewrites completed. From there another, lighter, review and rewrite followed by fine tuning and then the layout, design and publishing. Should be out this summer. Fingers crossed. It will be the book I wish I’d had at 15 too. Or 20. or 30. or 60 for that matter.

Since I’m a customer of Vanguard I get a stream of email updates from them, most of which I ignore. I guess I’ve been with them long enough and have done enough due diligence that I just don’t worry about it anymore.

I suppose if I were concerned or more interested, I’d look for articles on them in the on-line financial outlets like Yahoo Finance. Or maybe just Google them once in a while.

I just looked at the rules for SIPC coverage, and it seems that a person’s account with an institution is covered for $500,000 if the brokerage goes into liquidation.

That makes me feel more comfortable about having a larger account worth with Vanguard, and I suppose one could always buy Vanguard funds through a regular broker like Ameritrade when one reaches the $500k per “separate capacity”.

SIPC protection of customers with multiple accounts is determined by “separate capacity.” Each separate capacity is protected up to $500,000 for securities and cash (including a $250,000 limit for cash only). Accounts held in the same capacity are combined for purposes of the SIPC protection limits.

Examples of separate capacities are:

individual account;
joint account;
an account for a corporation;
an account for a trust created under state law;
an individual retirement account;
a Roth individual retirement account;
an account held by an executor for an estate; and
an account held by a guardian for a ward or minor.
Additional information on separate accounts may be found in SIPC’s Series 100 Rules.

The following are examples of separate accounts:

Mary has an account in her name at her brokerage firm. Mary is protected by SIPC up to $500,000.
Joe has two brokerage accounts, each in his own name. For purposes of SIPC protection, Joe’s accounts are combined, and Joe is protected by SIPC only up to a total of $500,000.
Joe and Mary are married and they have a joint brokerage account which is separate from the individual accounts that they each have at the firm. An additional maximum of $500,000 of SIPC protection is available for the joint account.
Joe has a Roth account and an IRA account, at the same brokerage. Joe is protected up to $500,000 for the Roth account and up to $500,000 for his IRA account.

This is a fantastically useful post. It answers lots of questions I often get asked as a fellow blogger and Vanguard fan.

Its so good and so useful that I would love to re-post it on my blog (rather than write an inferior version myself). It would of course be credited to you with a link to the original article on your site.

I can show you previous examples on my blog where other bloggers (eg Raptitude, Free to Pursue) have kindly allowed me to do the same thing:

First of I would like to thank you for writing this blog. It has been very informative. And has me changing my mind about how to invest as well.
All the breadcrumbs you leave behind kinda lead back to vanguard though. And being from Belgium, sadly, the people from my country aren’t lucky enough to have Vanguard present (yet?) out here.
Would you recommend Vanguard EFTs? Or would I be better of with another low cost index fund I can buy out here?

Great article. Clear and concise. Very interesting reading their disaster contingency plans. Makes me believe that the government does indeed have giant indestructible bunkers hidden somewhere in the desert.

As a matter of fact I just did a rollover to a Vanguard Roth IRA – VFIAX is the landing spot. I am glad that you wrote this piece Jim – as Buffett says, “It’s Armaghedden here every day.” I just left a career where it was my job to think of worst-case scenarios and by nature I’m wired to think what could go wrong with my thesis. The nuke or cyber assault on my investment houses is something I’ve thought about and I use two that I trust implicitly – USAA (where I hold Berkshire Hathaway) and Vanguard. The only risk that makes me truly “uncomfortable” is regulatory risk.